Schweser FRA, Pg. 182, last paragraph of LOS 27.e: “…When earnings are largely comprised of accruals, mean reversion will occur even faster.” This implies that for two identical super growth firms - the one with large accruals is likely to slow down quicker to normal levels than the one with higher cash flow. I am not sure how this is so since most start ups have huge accruals for some time and their life cycle for growth is longer - is the quote referring to the likelihood of higher growth (for a longer time than the higher accrual firm) for an equal start up but with huge cash flow? If so, can someone please explain how this works?
This is really relating to the amount of accruals within the financials as measured by Balance Sheet and CF accruals. It’s not relating to the life-cycle. These aggressive/conservative decisions that managers make will either shot more/less revenues not and more/less revenues in the future. In the long term you should see earnings going back to normal levels (defining normal as whichever state the actual company is in its growth stage) I hope I’m making some sense
I don’t think the text is implying accrual reversion = growth slowdown. Doesn’t mean reversion simply indicate that the earnings of the firm will drift largely back into cash?
i think Guille has it. Don’t over think this, accruals are basically poor quality earnings.
Thanks guys - these explanations make sense to me. So, to recap - given a similar financial fiscal period for two identical firms, the one with the higher accrual will have aggressively accounted for or captured higher revenues / lower expenses this period and therefore more stable revenues / expenses is likely in the future period (QUICKER mean reversion) - as opposed to higher cash flow which reflects less volatility in revenues / expenses this period and therefore similar revenues / expenses is likely in the future since cash is more difficult to manipulate (SLOWER mean reversion).
yeah pretty much, nice